RD cuts ARMs auction size citing dissatisfaction with quality of bidding

Realkredit Danmark (RD) took the unprecedented step of cutting a three year covered bond auction from Dkr2.72bn to Dkr1.90bn (Eu255m) on Wednesday, citing dissatisfaction with orders for the sale, although the bulk of the week’s issuance was relatively smooth.

RD began Dkr65.4bn of sales on Monday as part of more than Dkr165bn of auctions by Danish lenders this week and next, mainly to refinance adjustable rate mortgages (ARMs), and until Wednesday its sales had progressed smoothly, albeit at slightly wider levels and lower bid-to-covers than experienced by Nykredit Realkredit, the biggest Danish mortgage lender, and BRFkredit, which is raising just over half RD’s amounts.

Danske subsidiary RD then announced on Wednesday that it was cutting the size of a scheduled Dkr2.72bn sale of a three year bullet to Dkr1.90bn. It said that it would instead raise Dkr3.13bn yesterday (Thursday) and today (Friday), to achieve the Dkr13.6bn it had been seeking from the outset.

The issuer said in a statement that the decision to cut the size of Wednesday’s sale was taken based on dissatisfaction with the quality of bids relative to the general market. The bid-to-cover ratio was given as being 2.19 by RD against the revised amount.

It is understood to be the first time RD has reduced an auction thus, while a market participant said that he could not remember any auction being cut for such a reason before.

An analyst noted that RD had from the start of the week been generally experiencing less demand than Nykredit. On Monday RD sold Dkr2.72bn of the bond at a bid-to-cover of 2.54 while Nykredit on the same day sold Dkr1.2bn of its three year with a bid-to-cover of 5.08.

“The three year was all covered,” said the analyst, “but the problem was that some bids were too far away from what RD considered the ‘fair price’, so they cut off the lower bids.

“Fundamentally it is not a big problem,” he added, “but it did have a negative impact on the auctions.”

He said that the level at which RD sold the three year paper yesterday – with a bid-to-cover of 4.20 – was some 4bp wider than on Tuesday, and that the widening had had a knock-on impact on sales from other issuers, even if they were less affected. A funding official at Nykredit said that its sales were going as expected (see below for more details).

Because of the pass-through nature of Denmark’s traditional mortgage finance model, higher funding costs are passed on directly to an issuer’s borrowers.

“You could say that from RD’s perspective they couldn’t care less because they pass on the cost,” said the analyst, “but the problem is that they lose competitiveness. You can argue whether what they did with the auction is fair or not vis-à-vis the investors.

“I believe what they did was right. Some investors who were just trying to pick up cheap paper will feel they have wasted their time, but they will just have to stay away or put in firm bids.”

However, he warned that such a problem should not be considered unexpected given that the Danish refinancing season is, in his view, increasingly complicated, with almost 100 auctions over two weeks, and investors now having to analyse new angles such as the LCR-eligibility of each issue.

“For many investors it has become close to impossible to keep track of everything,” said the analyst.

A market participant meanwhile suggested that the relative levels of demand and pricing of RD versus its peers were due to LCR factors, with Danish banks not able to hold their own bonds for LCR purposes and RD parent Danske’s larger size versus Nykredit playing in the latter’s favour. Another market participant, however, noted that RD was simply selling larger amounts than Nykredit.

Ahead of the downsized RD sale, market participants had earlier in the week said the demand and levels achieved in the first auctions were surprisingly strong, with a drop in supply of ARMs cited as the likely cause. Nykredit noted that its Dkr21bn equivalent supply of one year ARMs is down almost Dkr90bn from a peak for the instrument, in 2009.

“The mortgage credit institutions have managed to move a lot of borrowers out of the one year to longer ARMs and other issues,” said Lars Mossing Madsen, chief dealer at Nykredit, “meaning the amounts of one year ARMs on these auctions are much, much smaller than we have seen in the past.”

Analysts had nevertheless noted that significant amounts of bonds will be sold by year-end after the auction season and that other potentially negative factors have been at play.

“We know that the lines the banks are giving to various accounts have been reduced over the years,” said Anders Aalund, chief analyst at Nordea Markets, for example. “Overall it was very difficult to predict the outcome.”

However, the first sales on Monday ultimately represented a positive outcome, according to Aalund and other market participants, with the spreads achieved even tighter than after a rally in the run-up to the sales.

“Overall it’s going well,” said Nykredit’s Madsen. “Interest has been mainly much higher and the level is basically 2bp-4bp tighter than we were expecting before the auctions.

At its first, Dkr3.2bn auction of one year ARMs on Monday Nykredit achieved a bid-to-cover of 3.78. That one year paper was sold at a level of 22.2bp versus Cita, according to Madsen, and the three years at minus 3bp.

BRFkredit joined the issuance on Tuesday and market participants noted that its one years had come roughly flat to Nykredit and inside RD paper, in contrast to its typical levels.

“That was surprising because they are normally 3bp-5bp cheaper than Nykredit and RD,” said one.